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China holds a unique position in the global economy, accounting for 18% of global GDP in 2021 but also subject to tight central control. The government's efforts to balance growth with ideology have already made an eventful 2021, including a broad regulatory crackdown on tech giants, ongoing tensions with the US and a potential real estate bubble.
These have caused significant volatility in equities markets and large sectors of the Chinese economy, with new measures last year targeting the booming gaming and tutoring sectors as well as halting China’s biggest ever prospective IPO, Ant Group.‘It was more or less a complete makeover of certain parts of the Chinese economy,’ says Martin Fechtner, Multi-Asset Portfolio Manager, Emerging Markets at ODDO BHF. ‘For the government it was important to send a signal to certain businesses that they had grown too strong.’
But in April and May this year, the economy growth froze due to Covid-19 lockdowns. It seems that the authorities have realized the risk and could not tolerate it. The national TV symposium gathered by prime minister Li Keqiang at the end of May clearly demonstrated zero tolerance to any potential recession. The government’s attitude turned supportive.
Stabilizing the economy growth now becomes a priority. We see accelerated issuance of expansionary monetary and fiscal policies, together with relaxations on the restrictions posed on “punished” sectors. The gaming approval freeze since July 2021 stops, and multiple measures are issued to boost demand and supply in the housing sector, incl. lower loan prime rate, lower down payment, reduce limitations to purchase, easier access to credit for developers, etc.
One of the key motivations of the strict policy restrictions last year was ideological, following the ‘Common prosperity’ doctrine aiming to reduce inequalities and maintain stability and power for the party. Over the long run, we believe the road to ‘Common prosperity’ remains intact. ‘Inequality is one of the most important issues facing the country,’ says Valérie Niquet, Asia Program Head at the Foundation for Strategic Research. ‘China is one of the most unequal societies in the world, with 600m having a revenue under €100 per month.’
Private business remains an essential part of China’s economic plans, with 90% of people employed in cities in private enterprises. The country also remains open to foreign businesses, with rules relaxing in the auto and insurance sectors, however the zero-COVID policies continue to hamper travel.
While the housing sector is a worry for many investors, contributing 30% of GDP, high levels of household savings and low loan to valuation ratios on mortgages could mitigate potential fallout. The Chinese government is disposed of a variety of tools that could impact both demand and supply, to avoid wild fluctuations of house prices.
The largest challenge may turn out to be China’s ambitious climate targets, looking to reduce fossil fuel usage from 90% of power production today to 20% in 2060. ‘The task before them is huge,’ says Dr. Axel Schweitzer, CEO of ALBA Group. ‘China is still growing, so they’re going to fully transform their energy mix while still running forward at full speed.’
‘China markets can change rapidly so it’s not enough to just pick stocks. Investors must understand how government policy and economic factors will affect equities in the short, medium and long term,’ says Ken Wong, Director, Client Portfolio Manager China Equities at Eastspring. Investing in China is intimately bound up with the ideological and political direction of the country, so investors have to focus on companies and sectors that can benefit.
As in the US, long term economic policy is being heavily driven by the need of self-reliance in industries such as electric vehicles, artificial intelligence, and semiconductors, as well as divestment from fossil fuels. In a structural transition from an export-led growth to a consumption-led growth, China is also attempting to boost domestic consumption, currently only 56% of GDP, which could also greatly benefit European luxury businesses.
Key sectors in the government’s 2021 Five-Year Plan for social and economic development comprise both the energy transition sector including renewable energy such as wind, solar and hydrogen power, as well as financial services such as wealth management, financial management and the insurance sector. However, volatility still remains – last year saw technology companies hit with strict new regulation – so a diversified approach is essential to spread risk. The key is to identify strong teams who can adapt to new regulations.
Sectors to be wary of include foreign-listed stocks as well as communications, utilities and energy, but despite uncertainty, investors continue to favour China for other sectors. Compared to the year 2020, the year 2021 saw more than doubled capital inflows into the A-share market through the Shanghai-Hong Kong Stock Connect thanks to attractive valuations, with businesses valued at 13x forward earnings, compared to 20x in the US as end of 2021.
The uncertainties over geopolitical tensions and covid-19 lockdowns have caused capital outflow of the A-shares market in March, with a 45-billion-yuan net outflow through the Shanghai-Hong Kong Stock Connect. However, compared to a complicated international environment, positive news in China and relative attractive valuations (11x forward earnings in China vs. 18x in the US as end of May) have attracted investors back to A-shares, especially with the lifting of Shanghai lockdowns. Capital flows into A-shares at an accelerated pace, 6 billion yuan in April, 17 billion yuan in May, 41 billion yuan from June 1st to June 10th.
While the EU recently published a report warning that the Chinese economy was turning inwards, there are positive signs. ‘The government is actually pursuing a dual circulation policy, driving domestic consumption at home, and seeking investment from abroad,’ says Yan Lan, Vice Chairman of Investment Banking at Lazard. ‘Although there are challenges, the new growth sectors in the digital economy, infrastructure and energy offer many possibilities.’
ODDO BHF Live 2022, Focus on China
Dominique Moïsi, Special Advisor for Geopolitics to Institut Montaigne;
Ken Wong, Director, Client Portfolio Manager China Equities, Eastspring ;
Yan Lan, Vice Chairman of Investment Banking at Lazard, Chairman and CEO of Greater China ;
Valérie Niquet Head, Asia Program, Foundation for Strategic Research ; Dr. Axel Schweitzer CEO of ALBA Group ;
Martin Fechtner, CFA Multi-Asset Portfolio Manager, Emerging Markets at ODDO BHF,
Yanxiu Gu, CFA, product specialist at ODDO BHF AM
This document has been prepared by ODDO BHF for information purposes only. It does not create any obligations on the part of ODDO BHF. The opinions expressed in this document correspond to the market expectations of ODDO BHF at the time of publication. They may change according to market conditions and ODDO BHF cannot be held contractually responsible for them. Any references to single stocks have been included for illustrative purposes only. Before investing in any asset class, it is strongly recommended that potential investors make detailed enquiries about the risks to which these asset classes are exposed, in particular the risk of capital loss.
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